Smaller companies specialists Ed Prendergast and Steve Black, Senior Fund Managers for the Pengana Emerging Companies Fund, which was launched in November 2004, say it’s possible to deliver alpha through the market cycle by targeting smaller companies.

The last 20 years have brought a bit of everything to contend with in markets, Ed Prendergast said. “It has been an incredibly interesting time to have been investing in markets. We have seen some extremes and it has been hugely challenging, but it has only galvanised our belief in smaller companies as a critical part of an investment portfolio.

“Across bull and bear markets, including major events such as the GFC, Covid, high and low inflation, and high and low interest rates, there have been opportunities to invest.

“This sector has been fertile ground for active managers to add alpha but it doesn’t just fall in your lap – this end of the market requires a special kind of focus, and it demands flexibility.”

Mr Black said a stable team, process, and investment philosophy has been critical over the journey. “Smaller companies provide a lot of choice but it all comes back to the people, the process, and the decision-making, and how well you complement each other as a unit.

“There may be plenty of choice but there are also many opportunities to make mistakes. And we’ve made our share of mistakes over 20 years, but how we then mitigate those and turn things around comes down to our unique combination of process and people.”

Since establishment in November 2004, the Pengana Emerging Companies Fund has delivered 12.1% per annum net of fees to investors, outperforming the Small Ordinaries Index by 7.2% per annum net of fees for the period to 31 October 2024.

In practical terms, $100,000 invested in the Pengana Emerging Companies Fund at inception would now be worth $983,844, whereas $100,000 invested in the Small Industrials Accumulation Index would have grown to $288,245 over the same period.

For the last 12 months to 31 October 2024 the Fund has returned 29.5% to investors net of fees. The Fund has approximately $800 million assets under management.

Notwithstanding the recent rally, Australian small cap industrials remain overlooked and creating a rare environment to invest. “This has seen part-time small cap investors leave the market, creating a number of highly attractive overlooked situations”, Prendergast said.

“We saw this after the tech boom in 2000, and in the aftermath of the GFC and Covid. We love uncrowded markets, confident that our patient, long term approach is likely to be rewarded. Our preference is for stable, long term growth stocks such as Generation Development, Propel Funerals, TechnologyOne, HUB24, Netwealth and Mainfreight.”

Prendergast and Black say the key to consistency is maintaining contact with company management. “We’re turning stones over continually to generate returns for the fund. In an inefficient area of the market there’s no substitute for meeting management personally”, Prendergast said.

The other key is to embrace volatility, which may be pertinent given the potential economic impacts of Trump’s second term as US President. “We are used to dealing with volatility, and it can provide opportunities for us”, Black said.

“When markets are weak there is often money taken away from small caps, and that disruption can result in incredible buying opportunities in companies with proven management, with longevity, and predictable earnings streams.

“Active stock picking works in the small cap space – it’s all enduring, delivers strong outperformance and strong alpha when properly managed”, Mr Black concluded.

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The draft report^[1] proposes four model alternatives to allocate employees new to superannuation into a default super fund that is more closely aligned to their best interests. These would replace the prescribed default super options currently contained in the industrial relations system (modern awards and enterprise agreements).

The report found that around two-thirds of members in default super funds remain with their fund. This may suggest they are not actively engaged with their super and potentially missing out on opportunities to maximise their retirement benefit.

In addition, an Australia-wide system for selecting default funds would reduce the incidence of employees having multiple super accounts and see those not nominating a super account being forced into a default fund only once, upon entering the workforce.

This would see an end to the ongoing proliferation of super accounts, leading to a reduction in overall fees through facilitating account consolidation into a single employee super account with a higher average balance. It’s estimated that this could save the 40 per cent of employees who have multiple accounts more than $500 per year^[2], equating to $150 million in savings across the workforce.

Steve Black, IOOF’s Head of Client Delivery commented, “We support reforms that make choosing a super fund simple and promote engagement. From our own fund research, we know that employees who actively choose their super fund make more informed investment decisions leading to higher super account balances and better retirement outcomes.”

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[1] Superannuation: Alternative Default Models, Productivity Commission Draft Report, March 2017.
[2] Australian Taxation Office – Australians losing thousands in super fees annually, 2015.

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Australian dollar on the downward track

The fall in the $A is not surprising over the previous six months however the speed of the correction was somewhat surprising, a leading fund manager says.

Pengana Capital emerging companies fund manager Steve Black says the $A fell almost 8 per cent, triggered by an RBA rate cut, and a stronger $US due to the first hint from the Federal Reserve that QE may taper soon.

This fall in the $A sparked international investors to dump Australian shares which had been seen as “safe” in recent times due to the relatively high dividend yields.

‘The domestic economy appears to have faltered in recent months, with retailers such as David Jones, Fantastic Furniture, Target and Myer reporting soft sales,’ says Black.

‘Consumer sentiment and business confidence surveys support this, suggesting a postponement of activity pending the outcome of the election in September. We have sold shares which are exposed to this weakness (eg Seek), and will revisit after results season.

‘The rising $A is another reason to avoid discretionary retailers, due to the rising cost of importing products from China in $US.’

Australian shares fell 4.5 per cent during May, driven primarily by a sharp correction in banks, property trusts and Telstra.

While industrial shares fell, resources stocks rose 2.5 per cent in a volatile month.

Small-cap stocks also fell sharply, although resources stocks were down 5.4 per cent despite the strength in larger mining shares.

Mining services stocks were hit by a number of profit downgrades, as the downturn we had feared kicks in, says Black.

‘This vindicates our move to dramatically reduce our weight throughout 2012, with many stocks in the sector down 20-40 per cent during May.

‘We had also taken profits in some of our larger holdings such as Amcom, and REA Group recently on valuation grounds, which protected us from some of the pain in May as these more expensive stocks fell harder than the overall market.

‘Our portfolio is reasonably well-positioned should the $A fall further, as we are not heavily exposed to discretionary retailers, and our holding in Resmed benefits from the translation of its international earnings back into $A at an improved rate.

‘We maintain a skew to stocks not heavily tied to the economy. The overall picture remains highly fertile for stockpickers, with recent volatility highlighting opportunities for both profit taking and selective buying where valuations have allowed.’

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